Accounting for CAPEX threshold and its change under IFRS
Many companies apply so-called CAPEX threshold to decide which assets to capitalize and which assets to expense in profit or loss, based on their acquisition costs.
I received many questions related to CAPEX threshold, so I selected one of them because it is the most complex one:
“We have a CAPEX threshold policy where we capitalize all assets with cost higher than the threshold.
Let’s say that the threshold is CU 1 000. What if we buy lots of assets at CU 700 each?
It does not seem OK to pass them in profit or loss because their total value is more than CU 1 000.
Also, how to set the threshold – any advice?
What happens if a company revises its capitalization threshold from CU 1 000 to CU 1 500 will be accounted for as change in accounting policy and will be applied retrospectively?”
IFRS Answer: Materiality and aggregation
It all has something to do with materiality and aggregation.
You need to set up your materiality level first.
What is material?
The standard IAS 1 Presentation of Financial Statements specifies that material is anything that could either individually or collectively influence the economic decisions that users make on the basis of the financial statements.
So it’s certain significance or importance.
An item can be important due to 2 basic factors:
- Its size – the purchase of the whole admin building will probably be material for a medium-sized company, but not the purchase of waste paper bin, and
- Its sensitivity – some items can be material not due to their size, but due to their sensitivity because they can have an impact on how other people perceive the company.
Typical example are bonuses to management.
They might not be significant – USD 1 or 2 mil. paid to CEO of some big multi-billion or gazzilion corporation is probably not material due to the size, but people always watch out on how the companies remunerate their managers and whether the shareholders are not in conflict with management.
Now, we will focus on the size.
Assessing the materiality
Materiality is something that must be assessed by each company individually.
The reason is that it depends on the company’s size, nature of operations, magnitude of individual information and its significance for financial statements etc.
Materiality is very judgmental and yes, each entity must determine it, there is no exact and explicit process of setting the materiality.
However, in September 2017, IFRS Foundation issued the IFRS Practice Statement n.2 titled Making Materiality Judgments.
This statement describes the process of setting your materiality levels, it has 4 steps – identify, assess, organize and review, and you can actually download the full practice statement for free at ifrs.org.
Individual or aggregate?
OK, so you set up your materiality.
The capex threshold is NOT a materiality, but it is very closely related to it and derived from it.
The capex threshold should be set in a way that the total amount of items expensed in profit or loss is not material.
So if the aggregate of small items not capitalized due to being lower than the threshold is lower than the materiality, then your threshold is set correctly.
Let’s say you set the threshold of CU 1 000.
Thus, everything expenditure over CU 1 000 gets capitalized as it is significant, and everything below CU 1 000 is expensed in profit or loss.
Now, what about the situation when you buy 5 assets, CU 700 each?
It means that you made a purchase of CU 3 500.
Individually, it is not material, because it’s below your materiality level or capex threshold.
But, in aggregate, it is material.
The standard IAS 16 Property, Plant and Equipment describes that in paragraph 9.
It says that it may be appropriate to aggregate individually insignificant items, such as tools or molds, and apply the recognition criteria to the aggregate value.
If the aggregate value is lower than your threshold, then expense in it profit or loss.
Revising your capex threshold
What happens when you actually change the threshold from CU 1 000 to CU 1 500?
How should you apply that change?
If you have set the thresholds, you should revise them each reporting period – that is at least once per year.
You should really look at whether the current amount is still immaterial, not affecting your users.
Should you reflect the change in materiality – or the change in capex threshold in this case retrospectively?
It depends on whether your capex threshold increases or decreases:
When your capex threshold decreases…
Imagine that some asset meets the definition and recognition criteria for property, plant and equipment under IAS 16, but you do not recognize it as an asset because its cost is lower than your threshold.
What actually happened?
You made an immaterial error, isn’t it?
Let’s say that your capex threshold is CU 1 000 and you bought a bookshelf for CU 800.
The bookshelf is a property plant and equipment because you plan to use it to store your office files for more than one year.
So you should capitalize it and depreciate it as an asset if you want to be 100% correct.
But, it is not material, so you can expense it. You just made an immaterial error in fact.
The next year your company shrinks for some reason, profitability goes down and smaller items become material.
You revise your capex threshold from CU 1 000 to CU 700.
And, what was immaterial error last year, becomes material error. Sometimes it’s not the case, but you should check that.
You should make a correction of this material error under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors – that is retrospectively.
The IFRS Practice statement that I mentioned also asks for it in the paragraph 80.
When your capex threshold increases…
When you increase the capex threshold, then material items become immaterial and thus there’s no cumulative error from the previous periods.
So no, if you revise the threshold upwards, there’s no need to correct.
Here’s the video summing up the issue:
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